What is a Perpetual Bond

Published on February 2017 | Categories: Documents | Downloads: 35 | Comments: 0 | Views: 253
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What is a perpetual bond? As the name suggests, these are bonds which do not have any maturity date and are hence perpetual. Since they are never redeemed, such debt instruments give the issuers the comfort that equity capital offers in their capital base. Hence treated as equity by issuers, particularly the banks. Even regulators allow them to treat such bonds as a part of a bank's tier-I capital, which traditionally comprise equity instruments. (While tier-II capital of a bank comprises debt instruments). But on the flip side, unlike equity, they have to be serviced perpetually by way of paying interest to the subscribers of such bond. Who are the issuers of such bonds? Globally, such bonds are issued essentially by entities in need of very long-term funds such as the government, banks and other financial intermediaries. But in India, it is an innovative instrument that the Reserve Bank of India allowed them to do a few years ago because of its equity like features, and are allowed to be treated as tier-I capital. Why is it relevant in India? After RBI stipulated banks to migrate to Basel-II or the new international bank supervisory practice, capital requirements of Indian banks went up. Allowing only pure equity instruments may not be adequate for banks. Hence, banks were allowed to raise perpetual bonds to meet their capital requirements. However, there is a growing debate that only pure equity and net worth should qualify as tier-I in the future. What are the features of such bonds in India? In India, innovative perpetual debt instruments presently qualify as tier-I capital. They can be issued as bonds or debenture in the local currency and the amount raised through such instruments is to be decided by the bank's board. They can comprise up to 15% of a bank's tier-I capital after deduction of goodwill and intangible assets, but before investments. Excess amounts raised will be eligible for tier-II capital. Such bonds can be called back by the issuer after a supervisory approval.

A statutory reserve is an amount of cash a financial institution, such as a bank, credit union, or insurance company, must keep on hand to meet the obligations incurred by virtue of accepting deposits and premium payments. The statutory reserves required of banks and credit unions are generally set by the nation's central bank, and those required of insurance companies are set by statute or regulation by the national, state or provincial government or regulatory authority. Calculated in various ways, statutory reserves are required to ensure that financial institutions are capable of paying claims even in a calamitous situation. Financial institutions like banks, credit unions and insurance companies derive their profits from the loans and investments they make with the funds that have been deposited with them. Other financial institutions, like brokerages, make their profits by charging their clients commissions on each transaction, and don't generally have access to their clients' funds for lending or investing, and thus are usually not subject to reserve requirements.

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